A Top-Down Investing Approach


Two common approaches to investment portfolio construction are bottom-up investing and top-down investing. A bottom-up investing approach is essentially an equity-picking method where you focus on individual security selection rather than a portfolio’s allocation to various security types, countries, company sizes or other characteristics. A top-down investing approach determines the allocation and selection of assets based on macroeconomic characteristics and how they are expected to affect different areas of the market. Once the investors have identified the areas they think will perform well in their top-down approach, they can select individual securities within those areas.

Top-Down vs. Bottom-Up Investment Approaches

In a bottom-up portfolio, the direction of the total portfolio is guided by the selection of preferable individual securities. As a result, a bottom-up portfolio may be limited to the investor’s knowledge of individual securities and may lack a comprehensive long-term strategy.

Alternatively, in a top-down portfolio, broader economic analysis and forecasting drives tactical decisions. A top-down portfolio considers the wider economic and macroeconomic context before moving to security selection. Your analysis and forecast should then guide which security characteristics—such as sector, style and country—should be targeted based on economic conditions. By narrowing down the options, Fisher Investments UK believes you’ll have a better chance of selecting successful securities.

In other words, why search for the needle in the haystack, when you can search for the haystack with the most needles?

Fisher Investments’ Top-Down Approach to Investing

Fisher Investments UK delegates portfolio management to its US-based parent company Fisher Investments. Fisher Investments believes the majority of investment returns are a result of asset allocation—a portfolio’s mix of equities, fixed interest, cash and other securities. Therefore, choosing your asset allocation may play a more significant role in your long-term portfolio returns than your choice of individual securities.

For example, compare an all-cash portfolio with an all-equity portfolio. Over time, you might see a bigger difference between the all-cash and all-equity portfolio compared with two all-equity portfolios holding different equities. The type of assets you hold could play a major role in determining your longer-term returns. Because of this, Fisher Investments believes you should first consider selecting the best asset class for your needs to invest in before analyzing individual securities.

When investing in equities, you should consider the overall market environment and decide where to invest based on the outlook for each country, sector or company size and how they have performed at similar points in earlier market cycles. For example, if you find large-company equities have historically performed better late in a bull (upward trending) market, you may want to emphasize these equities in your portfolio.

Fisher Investments’ Top-Down Approach to Investing: 70/20/10

We believe 70% of investment returns are attributable to a portfolio’s asset allocation, 20% to category decisions—what we call sub-asset allocation—and 10% to the selection of individual securities. Exhibit 1 shows the progression of our 70/20/10 model for reference:

Exhibit 1: Fisher Investments’ 70/20/10 Investment Approach

*Forward-looking return attribution is an approximation intended for illustrative purposes and should not be considered a forecast of future returns or return attribution.

Here is a more detailed look at the chart:

The Fundamental Market Drivers:

  • Economic drivers include factors such as central bank interest rates, the yield curve, equity supply and economic growth.
  • Political drivers include factors such as government stability, trade practices and capital barriers.
  • Sentiment drivers include factors that show how investors feel about the market: essentially, do expectations match, exceed or fall short of fundamentals? These can include factors such as fund flows, professional investor forecasts and media coverage of markets and the economy.

The 70/20/10 Approach:

  • 70%: Asset allocation: You can determine your portfolio’s mix of equities, fixed interest, cash and other assets using your analysis and forecast of macroeconomic factors. These may include the current economic environment, investor sentiment and political and regulatory risk. Because asset allocation is a crucial factor contributing to a portfolio’s returns, we treat it as the highest-level decision.
  • 20%: Sub-asset allocation: This step is about narrowing down your list of possible assets based on characteristics, such as country and sector. We select categories based on many factors including historical analysis to determine which assets are likely to outperform over a period of time.
  • 10%: Security selection: This portion is about picking individual securities within your determined sub-asset allocation. This direction from the first two steps provides a framework for which securities to consider in this stage.

Putting It Together: A Top-Down Approach on Two Main Levels

Think Strategically: Select Assets to Match Your Goals

Your long-term goals should determine your investment strategy in a top-down approach. A well-designed portfolio should be personalised to match your individual situation. There is no one-size-fits-all solution to choosing asset classes.

For example, if you have significant growth needs, you may benefit from investing in assets that have historically provided higher returns along with higher short-term volatility, like equities. If you require less growth and need more cash flow, you may be better off increasing your portfolio’s allocation towards assets that have historically provided lower long-term returns and lower short-term volatility, like fixed interest.

Think Tactically: Use Market Forecasts to Adjust Your Asset Selection

Once you have identified the right asset mix to match your goals, you can then make decisions on a tactical level to try to improve your portfolio’s performance over time.

Most of these decisions will be tied to market forecasting. Here are a few examples:

  • Asset Allocation: If your research and forecast leads you to strongly believe in the possibility of a market downturn, you may decide to switch to more defensive assets. However, this can be a risky decision. You should use extreme caution and refrain from going defensive for emotional reasons, such as reacting to political news or newspaper headlines. A professional adviser can help calm your fears and keep your goals on track. After all, we believe positive investment returns have more to do with time in the market rather than timing the market.
  • Sub-asset Allocation: Based on your ongoing market forecast, you may wish to hold fewer securities in areas you think might underperform the overall market and hold more of what you believe might outperform. For example, if you anticipate European equities to outperform this year, you might choose to hold more European companies in your portfolio. However, you may want to avoid holding too many correlated assets in a given sector or particular region of the world, as that may magnify your risk.

Portfolio management is complex, as market conditions are always changing and financial media can be difficult to understand. Having an adviser to do the research and keep you focused on your long-term financial goals can give you some helpful counsel and peace of mind.

Fisher Investments’ Investment Philosophy

We believe a top-down investment approach—one that selects assets based on higher-level analysis before security selection—is a key factor to our investing success. To learn more about Fisher Investments and Fisher Investments UK, download one of our guides or contact us to speak with one of our qualified professionals today.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.